Sunday, December 23, 2007

Nobel-winning economist Vernon Smith had an editorial on housing issues in the WSJ the other day here, but you need to be a subscriber -- Murdoch hasn't opened the site up yet!).

Vernon makes a few points, including blaming the "housing bubble" on cuts in capital gains taxes for houses. That might have had some impact on housing prices, I have to agree, but I don't think that was the only reason for the rather spectacular rise in housing prices the last 10 or so years (low interest rates, increased credit available for housing purchases, and simple supply and demand also play large roles).

But Vernon also argued that the investments in housing were to a great extent a waste of resources and went mostly to the rich. Even more bothersome to me, he compared the housing investments to the investments made during the late 90's tech boom and argued that those tech investments were good, in that they contributed to productivity gains for companies.

It would be good to have some more facts at hand, but on the basis of my observations, I think he has it backwards. The housing investments have been for housing, which is generally occupied. And these investments have obviously not just been for the wealthy -- the wealthy don't qualify as subprime risks. Generally the housing boom has expanded the supply of housing, and made home ownership more affordable for many of lower income. We should all keep that in mind when criticizing the mortgage industry for making subprime loans -- even with a lot of defaults, there will still be a lot of lower income folks in houses that they own instead of rent. That is a good thing.

And for Vernon Smith to argue that the investments of the tech boom were all good makes me think he must not have been watching during that period. Much of the investment of the tech boom was not in real capital but instead in human capital. All the startup internet firms were not investing much at all in physical capital; they were investing in salaries of programmers and managers, many of whom had advanced degrees. And these companies were also employing armies of consultants and investment bankers, who are also obviously of higher income classes. Some companies were investing in physical capital, such as the firms in the telecommunications industry that built more fiberoptic network than could be economically justified even at zero discount rates.

So before we condemn the housing investments as clearly wasteful, especially in comparison to the investments of the tech boom, we should pause and, even better, collect some data and do some analysis.

The story two weeks ago about the NIE (National Intelligence Estimate) on Iran and how that country likely stopped pursuing nuclear weapons in 2003 still demands explanation. Some folks think it was sabotage by some elements within the US intelligence community. That is possible, but not my favored explanation. What strikes me as incredible is that the administration seemed to be caught off guard by the report. How could that possibly happen? The report had to be in the making for weeks, and I just cannot believe that the top intelligence officers would not know how it was going to come out. A conspiracy that deep could never be kept secret. Is there another explanation for the report that also explains the seeming surprise/ignorance of the administration?

Now in today's papers comes another story, citing a US official crediting Iran with helping (!) to limit violence in Iraq. This also comes just in advance of another meeting between US and Iranian diplomats.

Could the NIE estimate be more purposeful than many think? Maybe the deal, even implicitly, is that the US will back off the rhetoric on Iran's nuclear ambitions, and in turn Iran will back down on its support of Iraqi violence. Maybe there is some signaling going on from each side, with the intent of moving forward in a more friendly, negotiated fashion.

This theory explains the Administration's seemingly surprised and ignorant stance as being much more strategic, using the feigned ignorance to avoid admitting that they are offering Iran a fig leaf.

The fact that both sides seem to be giving in a little supports my theory. The test of competing theories will lie in what happens in the coming months.

But all in all, the NIE report remains another case of "there's something happening here and we don't know what it is."

About Me

I was born in the Upper Peninsula of Michigan, went to Northern Michigan University undergrad and UCLA for my PhD in economics. I am the Senior Associate Dean and Professor at the Tuck School of Business at Dartmouth College. I lean libertarian, but for lack of political success on that front I tend to support the Republican Party.
The usual boilerplate applies: What I write here represents only my views, not those of my employer.